Friday, November 25, 2022

More On The Creaking Treasury Bond Market

In a recent post I pointed out that liquidity in the secondary market for US Treasury securities is at the lowest point in years, creating serious problems for dealers, traders and the Treasury itself.  I did some more data mining in SIFMA  and came up with the chart below.

You can see that the average daily volume in all Treasury securities (bills, notes, bonds, TIPS) as a percentage of all marketable Treasuries outstanding (ie excluding those held in the Social Security accounts) is at the lowest level ever.  The big drop in activity came about after the Debt Crisis in 2008-09 and has been falling steadily since.

This drop in activity is very worrisome, particularly now when the spike in inflation has led to sharply higher interest rates and an increase in new bond issuance to cover higher budget deficits and debt service payments/refinancing.

Why did activity drop in the secondary market?  Partially, it is due to the sharply higher amount of bonds held by central banks, particularly the Fed, which now owns 6 times more Treasuries than in 2008.  Such holdings don't trade, so the percentage traded has come down - but this can't explain everything.

Amount Of Treasury Securities Held By The Fed

Something else is going on… it could be the near zero interest rate environment that held for such a long time sapped all desire to trade - there was very little price volatility for years on end. Also, investors had no reason to sell their older higher coupon bonds since they could not replace them.

No matter the reason, low liquidity and low volume is troubling and could create serious problems for the government’s finances.

Inflation and Wages - A Follow Up

Following up on yesterday's post on how inflation is eroding the buying power of the average American and European wage earner and the upcoming strikes in key sectors like rail, mail, education and health.

It has been decades since unions flexed their muscle - indeed, unions have become emasculated. In the US private sector only 6.1% of workers are unionized today, a far cry from almost 35% in 1960.  The primary reason is the de-industrialization of the US/West, particularly after China became the world's factory.  I am certain that this shift of production from West to East (it started with Japan, remember?) is one of the stupidest socioeconomic decisions made by all Western leaders, bar none. Pardon the "stupid", but as a trained engineer I understand very well how production drives R&D advances and quickly leads to technological supremacy.  Lose your technological edge and you destroy your high value-added economy and your prosperity - period.

The loss of manufacturing jobs emasculated the entire middle class, now but a shadow of its former glory.  And along with that, has come the rise of populist politics, and politicians promising to Make America Great Again.  It is happening everywhere: in the US, France, Italy, Brazil, Austria, Poland, Hungary... it is no accident that Germany, the only Western economy still boasting a large and solid manufacturing base, has not fallen victim to populism - at least not yet.

It was a matter of time, then, that something would give and social unrest would follow.  Soaring inflation and loss of real income is now threatening to throw the West into a vicious cycle of social unrest.  It is no accident that Russia/Putin is taking advantage of this situation, hitting Western economies in their soft underbelly: energy, food and transport.  And it is still early in the game.

What should the West do? Here's a list, from immediate actions to longer term:

  1. Substantially raise minimum wages - at least to cover inflation.
  2. Do everything necessary to kill inflation immediately: raise interest rates at least at or near inflation levels AND get rid of excess liquidity ASAP.
  3. Promote saving instead of spending. Pressure banks to raise deposit interest rates.
  4. Raise corporate taxes, enforce minimum tax policies and invest the proceeds in alternative energy technologies, public transport, technical education and R&D.
  5. Provide serious incentives to bring factories back. Perhaps impose trade/import restrictions.
  6. Promote "buy local" policies, with tax incentives.
  7. Seriously evaluate the consequences of getting rid of WTO, replacing it with bilateral/multilateral trade agreements. 
If the West - and by West I mean 70% USA, 20% EU, 10% Japan - does not act immediately, it will fail spectacularly and suddenly.  There is no time left for navel gazing.


Thursday, November 24, 2022

Real Wages Eroding Fast, Strikes On The Horizon

With inflation running hot in the US and Europe, labor unions are preparing massive strikes not seen in decades.  

US railroad employees are set to strike next month, though the federal government will likely step in and impose labor terms, as it has the right to do in order to prevent the economy from grinding to a halt (40% of all goods move by rail and many commuter trains use private railroad tracks). In the UK rail workers are also set to strike in December, joined by university professors, teachers nurses and mail workers.

Can you blame them? In the US consumer inflation is rising much faster than pay raises, resulting in negative real wage growth (see chart below).  

Real Average Hourly Earnings - Annual Percent Change

Lower/middle income workers feel the pinch much more, since a greater portion of their earnings go to buy essentials like food and transport where prices are rising faster than overall inflation: Food and beverages are up 10.6% and transport up 11.6%, while overall CPI inflation is up "only" 7.8%.  For them, wage erosion is closer to minus 5% - 6% instead of 3%.

Service workers in Amazon or Twitter may be laid off in droves without immediately causing an economic upheaval, but essential workers are a different matter altogether.  Expect more labor actions to surface in the immediate future.

Tuesday, November 22, 2022

It's Deja Vu (All Over Again)

 Very short post today.

The gut feeling I get from all markets these days is that I've seen it all before, specifically during 2007-08.

Back then the Debt Crisis started slowly at the very edge of the risk/credit/real estate spectrum, ie subprime loans for speculative type properties.  Some mortgage brokers started going under, then specialist mortgage lenders (remember Countrywide?) and - finally - the doodoo hit the fan all at once: venerable investment banks who had bought and securitized loans and derivatives went bankrupt or were bought/bailed out for peanuts, seemingly overnight. The Fed saved the day by providing massive liquidity in amounts that looked immense - back then.

Today, the "edge" of the credit/risk spectrum is in cryptos and their associated exchanges and lenders.  They are now going under leaving behind losses in the billions.  Since the financial system is highly interconnected, however, I'm waiting for the next domino to fall, and it won't necessarily involve cryptos.

Once the Risk switch is turned to the OFF position all manner of critters are going to be rushing for the exit doors.

Monday, November 21, 2022

COP27 Ends In Failure

The COP27 conference just ended in abject failure, as leaders failed to agree on the mitigation of emissions from fossil fuels and arresting global warming. Not surprising. God help us and our children, because global leaders won’t.

Below, relevant charts. 

Fossil Fuels Are 80% Of Our Global Energy Consumption

CO2 Emissions Have Risen 800% In 70 Years

Global Land-Ocean Temperatures Up 1C In 40 Years

Heat Map In 1950

Heat Map In 2022

All charts are alarming, of course, but the last one is particularly so.  It shows that Arctic temperatures are rising the fastest,  4C+ over average.  This means:

  • Polar caps are melting fast, raising sea levels
  • The Siberian Arctic tundra holds immense amounts of trapped methane near its permafrost surface. Methane is up to 80 times more damaging as a greenhouse gas and its release will act as the most powerful accelerant of global warming/climate change, much more than CO2.  It means that we may see climate and habitat disasters happen within years, not decades.  

Friday, November 18, 2022

The Most Important Market In The World Is Creaking

The stock market gets the glory (incessant publicity), but the most important market in the world is the bond market, particularly US Treasurys. Everything, and I do mean everything, is ultimately based on it. It hasn’t always been so, but ever since the abolition of the gold standard in 1970’s, and more recently the emergence of shadow banking and the effective abolition of bank reserve requirements has led to an explosion of debt. 

Yes… Sudden Debt…

Obviously, the proper functioning of the US Treasury market is of paramount importance: liquidity, breadth, depth, transparency and regulatory oversight are the cornerstones of any market and are taken for granted for Treasurys.  Lately, however, something is seriously wrong as the chart from a very important FT article shows.

Liquidity, measured as the amount of a single trade that can be executed without seriously moving the market up or down,  has deteriorated to dangerous levels at the very time that the size of the market has quintupled. In 2010 liquidity stood at almost $800 million and today at just $100 million.  As a ratio of the total market, liquidity has collapsed 97.50% from its 2010 levels. Another way to look at it: for a bond trader it is now 42 TIMES more difficult to execute trades in US Treasuries - in equivalent market size. 

In practical every day terms it's not as bad as that because a chunk of Treasuries sit at the Fed's balance sheet, around $5.5 trillion worth. Still, it's bad enough.  Furthermore, the Federal Reserve Bank is ultimately... a bank!  At the end, it too has to take into account how heavily exposed it is to its borrowers and how liquid is its portfolio.

As a bond market professional, this liquidity plunge is really scary.  It could create enormous price volatility in the market, a possible repeat of what we saw in UK gilts recently, but magnified many times over.  If it happens, it would necessitate the massive intervention of the Fed in the form of another QE, at a time when we need the exact opposite (QT).to tame inflation. 

Wednesday, November 16, 2022

Fed Funds Projections

Markets seem to be monothematic these days: it's all about the Fed.  How fast will it raise rates and, even more crucially, how high will it raise them from today's 3.75-4.00% band.  With this in mind, here's a chart I came up with with data from the CME's Fed Funds futures market

The blue bars (left scale) show the Fed Funds rate and the orange line (right scale) shows the highest probability associated with this rate, as implied from the futures market.

Interpreting the chart, the market is betting that the Fed will immediately temper its hikes to 50 basis points next month, giving that scenario an 81% probability, and will subsequently raise by only 25 bp, but give this a lower probability of 50%. Further, the chart says that rates will top out at 5.00% by March and stay constant until late next year, but with ever lower certainty.  To be clear, the orange line involves the rate that shows the highest probability - others are for lower or higher rates.

Saturday, November 12, 2022

We’re Sorry If You’re Starving, But…

 The iconic Harrod’s of London decided to go all out this Christmas and, in cooperation with Dior, transformed itself into a giant ultra luxury gingerbread house bedecked with thousands of lights showcasing products that are far beyond the reach of even the merely rich, never mind the middle class. 

The manager of the store said - on camera! - that he’s truly sorry for those Britons that are in trouble, but Harrod’s only caters to the 0.1% of the ultra rich. Never mind being socially incredibly deaf and blind, a supersize retail establishment like Harrod’s cannot long survive with the custom of only 68.000 Britons plus some visiting tourists. I mean, if you are one of other 99.9% do you now feel welcomed? Do you really want to set foot there, even if only to buy a trinket? Is the Harrod’s brand now one that you want to be associated with?

The fact is that a whopping 25% of all Britons, some 20 million, cannot afford to heat their homes this winter: for them, it’s heat or eat. Yet, the 0.1% store says they’re truly sorry.  Like Dickens’s Tiny Tim from A Christmas Carol, 20 million cold and underfed Britons could crowd outside and stare at the store windows in wonderment. Hopefully, they won’t decide to start throwing bricks.

Wednesday, November 9, 2022

The All-American Sandwich

 Final results for yesterday's mid-term elections are still being calculated, but this picture (see below, from Reuters) speaks volumes.  It's the House of Representatives map, awash in red.  Yes, its pretty misleading because the large population centers with their large numbers of House seats are actually blue, but it is troubling nevertheless.

Basically, the map says that America's affluent liberal coasts are completely at odds with everyone else who is poorer and socially conservative, or even regressive. It's a recipe for a social/national disaster: America is not a single country but a federation of States.  Why should the approx. 40 red States stay in a union with the other 10 if they hate each other? The Reds produce most of the food, energy, minerals and forestry products - what do the Blues make that is essential to survival?

America is a very fat red sandwich with two very, very thin slices of blue bread.  Perhaps the red "meat" may decide it does not need bread, after all?

For comparison, see below the same map for the 1978 mid-terms.  Why 1978? Because like today, Jimmy Carter was a deeply unpopular Democratic President faced with an energy crisis and soaring inflation. Yet the nation was much more balanced and united, even if angry.

Tuesday, November 8, 2022

Stage Management

 I cannot shake the feeling that for the past couple of months the US stockmarket and the price of gasoline at the pump are being manipulated, stage managed if you like, ahead of today's crucial mid-term elections. 

I strongly believe that these mid-terms are the most important since at least WWII.  The confluence of economic, financial, social and cultural issues is creating an unprecedented political tinderbox for the US, far beyond anything we have experienced in our lifetimes.  I think President Biden is right in saying that "democracy is at stake", though it doesn't necessarily follow that voters should cast their ballots for Democrats.  Indeed, America faces far more important issues than Blue-Red politics.

Back to stage management: there is no question that gasoline prices at the pump are being suppressed, mostly by massive domestic oil releases from the Strategic Petroleum Reserve, which has now fallen by 45% to 40 year lows (chart below).

What is very peculiar is that while gasoline prices are being kept low, diesel fuel (also used for heating) is soaring to new highs (chart below).

US Prices for Diesel (red) and Gasoline (blue) 

The spread between the two has reached unprecedented highs (chart below).

Spread Between US Diesel And Gasoline Prices Reaches Record High

Unlike Europeans, Americans don't drive many diesel cars, preferring gasoline ones instead.  The country consumes three times more gasoline than diesel/heating oil.  Therefore, voters are not experiencing "pump shock", just now. However, diesel is essential for moving goods in trucks and trains, as well as heating homes where natural gas is not available.  Therefore, it plays an important role in shaping consumer inflation, even if voters don't see it everyday driving to and from work.

As for stage managing the stockmarket: while tech companies are taking a massive beating, broad averages like SP500 and the ever popular Dow 30 are not.  Why? Because (a) oil companies are soaring (b) "defensive" shares like pharma are holding up and (c) Apple, the biggest biggie of them all, is also holding up, comparatively.

The election will be over today. No matter what the result, I believe stage management will also be over today.  Let's see how markets fare then.